A foreign exchange crisis at the beginning of 1991 forced the Indian government to recognize the depth of the country's economic crisis and introduce a restrictive fiscal and monetary stabilization programme. In Discussion Paper No. 920, Research Fellow Willem Buiter and Urjit Patel note that fiscal rectitude in the last two years has not corrected for the profligacy of the 1980s. The overall public sector financial and primary deficits have declined in relation to GDP, but the debt/GDP ratio and the present discounted value of the public debt in rupee terms have continued to rise, albeit at reduced rates. Public spending on capital has reduced but the unreformed structure of taxation continues to rely unduly on indirect taxes, whose severe distortions reflect a chaotic system of overlapping tax administrations with numerous exemptions granted at union, state and local levels. The central government has borne the brunt of this fiscal adjustment as the present minority administration has been unable (and unwilling) to impose a restrictive fiscal policy on the states to the extent required. Public sector enterprises (PSEs) remain a large net drain on the government's financial resources, and efforts to privatize them have been very limited. India must generate primary surpluses to stop the present discounted value of its debt from rising further, and even maximal use of the undesirable inflation tax could do little to bridge the gap between expenditures and current revenues.

Buiter and Patel conclude that the Indian government must expand both its direct and indirect tax nets and reduce spending on its own wage bill, subsidies to food and fertilizer and operating and capital subsidies to PSEs. Those producing private goods and services, which form the overwhelming majority, should be privatized. Subsidies should continue only if `efficient' prices lead to systematic losses and the resulting benefits exceed the cost of raising the public revenues required from elsewhere.

Indian Public Finance in the 1990s: Challenges and Prospects
Willem H Buiter and Urjit R Patel

Discussion Paper No. 920, March 1994 (IM)